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Comparing Real and Nominal GDP: A Detailed Explanation

( By Mohan Bhulani) : The value of all products and services produced in a nation in a given year, assessed at constant prices, is known as the real GDP. It is therefore adjusted for inflation in order to provide a more realistic depiction of economic growth over time. The GDP deflator, a price index that gauges the average cost of goods and services in the economy, is used to compute real GDP by dividing nominal GDP.

The value of all products and services produced in a nation in a given year, assessed at current market values, is known as nominal GDP, on the other hand. It is the most widely used GDP metric and is frequently used to monitor changes in the state of the economy over time. However, because prices for goods and services tend to rise over time, inflation may skew the nominal GDP. This implies that even in cases where there has been no change in the real quantity of goods and services produced, the nominal GDP may rise.

What Makes Real GDP more Precise?

Since real GDP is corrected for inflation, it provides a more realistic picture of economic growth over time. The rate of increase in the cost of goods and services is known as inflation. The real growth of the economy might be hard to follow when inflation is strong. This is due to the fact that inflation can cause nominal GDP to rise even when actual production levels of goods and services remain constant.

Contrarily, real GDP uses constant prices to exclude the impacts of inflation. As a result, it offers a clearer image of the real amount of output generated in the economy.

When to Use Nominal vs. Real GDP

When comparing the sizes of economies in various nations and tracking economic progress over time, real GDP is typically a more useful metric to employ. Nonetheless, nominal GDP can still be helpful for a few things, like:

Monitoring government spending and revenue: Generally, nominal terms are used to describe government spending and revenue. This is due to the fact that it is critical to be able to compare the amount of the public budget over time.

Comparing the sizes of economies in various nations: It’s critical to convert GDP data to a single currency when comparing the sizes of economies in various nations. Either real GDP or nominal GDP can be used for this. But it’s crucial to remember that nominal GDP is subject to inflation, which is why real GDP is usually regarded as the more realistic metric.

Examples

Here are some examples of how real GDP and nominal GDP can be used:

  • Real GDP:
    • To track the long-term growth of the economy and assess the standard of living.
    • To compare the economic performance of different countries over time.
    • To make informed decisions about economic policy.
  • Nominal GDP:
    • To calculate government revenue and expenditure.
    • To compare the size of economies across different countries.
    • To track the growth of the economy in the short term.

Both nominal and real GDP are significant indicators of economic activity. But because real GDP is adjusted for inflation, it’s generally thought to be a more accurate indicator of economic growth over time. There are still some uses for nominal GDP, such as monitoring public spending and revenue.

 

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